US Internal Revenue Service: reforest

8/14/2019 US Internal Revenue Service: reforest

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Market Segment Specialization Program

The taxpayer names and addresses shown in this publication arehypothetical. They were chosen at random from a list of names ofAmerican colleges and universities as shown in Webster's Dictionary or from a list of names of counties in the United Statesas listed in the United States Government Printing Office Style Manual.

This material was designed specifically for training purposes only.Under no circumstances should the contents be used or cited asauthority for setting or sustaining a technical position.

Department of the TreasuryInternal Revenue Service

Training 3149-124 (8/95)TPDS No. 83994P

MSSP

ReforestationIndustry



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iii

Reforestation Industry

TABLE OF CONTENTS

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viii

Chapter 1 -- Return Selection Process

Returns Selected for this Project . . . . . . . . . . . . . . . . . . . . . . . . 1-1

Suggested Sequence of Selecting Contractorsfor Examination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1-2

Chapter 2 -- Nature of Operations

Overview of the Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-1

Federal and State Agencies IssuingReforestation Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-1

Private Companies Issuing ReforestationContracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-2

Types of Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-2

General Requirements for State and FederalAgencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-3

State of Oregon - Bureau of Labor andIndustries - Wage and Hour Division -

Oregon Farm/Labor Contractor'sLicense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-4

Workers' Compensation Carrier - SAIFCorporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-6

State of Oregon - Worker's Compensation . . . . . . . . . . 2-6

State Regulatory and Licensing Offices . . . . . . . . . . . . . 2-7

Bonding Requirements . . . . . . . . . . . . . . . . . . . . . . . . . 2-9



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Law Administered by U.S. Departmentof Labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-9

Chapter 3 -- Contracts in General

Mailing List . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-1

Solicitation Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-1

Contract Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-2

Delivery/Performance Requirements . . . . . . . . . . . . . . . . . . . . . 3-3

Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-4

Chapter 4 -- Pre-Audit Analysis

Analysis of Information Accumulated BeforeStarting the Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-1

IRP Transcripts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-1

Document Request . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4-2

Chapter 5 -- Interview

Importance of the Interview . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-1

Review of the Basic Techniques . . . . . . . . . . . . . . . . . . . . . . . . 5-1

Guideline for Interviewing the Contractors . . . . . . . . . . . . . . . . 5-2

Suggested Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-2

Business Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-2

Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-3

Accounting Records . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-3

Employee versus Subcontractors . . . . . . . . . . . . . . . . . . 5-3

Living Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5-5



v

Touring the Premises . . . . . . . . . . . . . . . . . . . . . . . . . . 5-4

Chapter 6 -- Accounting Records

Accounting Records in General . . . . . . . . . . . . . . . . . . . . . . . . 6-1

Cash Method of Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-1

Accrual Method of Accounting . . . . . . . . . . . . . . . . . . . . . . . . 6-2

Chapter 7 -- Employment Taxes

Employees in General . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7-1

Issues Generally Encountered . . . . . . . . . . . . . . . . . . . . . . . . . . 7-1

Subcontractor Payments . . . . . . . . . . . . . . . . . . . . . . . . 7-2

Cash Wages Deducted on the Return . . . . . . . . . . . . . . 7-4

Unsubstantiated Cash Expenses . . . . . . . . . . . . . . . . . . 7-4






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INTRODUCTION

This report is a culmination of the results of the work performed by a team of individuals from Examination, Collection, and the State of Oregon RevenueDepartment. The primary objective of this group was to evaluate compliance within a

specific group of taxpayers and to develop an industry/project report to be used as areference tool by State and Federal examiners. A team audit approach was used tomaximize audit resources and develop communication lines between the State of

Oregon Revenue Department, the Examination Division, and the Collection Divisionof the Internal Revenue Service.

The team consisted of four revenue agents from Examination, one revenue officerexaminer from Collection, one tax auditor from Examination, one revenue agent fromthe State of Oregon, and an audit accounting aide from Examination. The audit

techniques presented in this report were used by the examiners and have been found tobe useful within this industry.

The basic goals of the members of this team are outlined below:

1. To determine if compliance was a problem in this industry. 2. To determine if the contractors were filing all required Federal and State returns:

Income tax, employment tax, and information returns.

3. To determine if the Federal and State returns filed by the contractors were

substantially correct.

4. To make the appropriate recommendations to the proper State and Federalagencies, in order to strengthen voluntary compliance within this industry.

This report is based upon information gathered from a limited number of examinations.

It is, therefore, not to be considered all inclusive or absolute as to its contents. Theprimary purpose of the report is to provide some general and technical informationwhich should be useful to an examiner in the classification, pre-planning, and

examination of returns selected in the reforestation industry.

The audit areas identified and discussed in this report were considered to be significant

or unusual enough to warrant comment. The mere fact that an item is addressed inthis report does not imply, in any manner, that it must or should be examined in every

case. To the contrary, it is intended that the discussion for any one audit area willassist the examiner in deciding whether the item would warrant examination on a caseby case basis. This handbook was developed as a reference tool and should be used as

a supplement to the manual.






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Chapter 1

RETURN SELECTION PROCESS

RETURNS SELECTED FOR THIS PROJECT

Contractors were selected from the list of licensed Farm/Labor Contractor's, providedby the Bureau of Labor & Industry, Wage and Hour Division. A data base of thelicensed contractors owning businesses in Salem, Woodburn, Mt. Angel, and the

surrounding area was developed. AIMS was researched to locate social securitynumbers and addresses of the licensed contractors. Once a social security number wasobtained, a transcript was ordered to determine if the contractors were filing Federal

tax returns. Copies of selected contractors' returns filed with the State of Oregonwere secured from the Department of Revenue under our information exchange

agreement. The returns examined were selected based on prior knowledge of thetypes of expenses common to the reforestation industry and whether or not the itemsreported on the return appeared either large or unusual. The returns selected for

examination were either individual Forms 1040, Subchapter S-Corporations, orC-Corporations. The group examined 9 prime contractors, 3 second-tiersubcontractors, and 20 individuals who filed Federal returns Form 1040. The State of

Oregon revenue agent examined the Corporate Income Tax Returns for threeS-Corporations and one C-Corporation. The second-tier contractors were selected byexpanding the "package audit" during the examination of the prime contractor. In

other words, when a prime contractor was audited, the examiners reviewed certaindocuments (such as canceled checks, invoices, and Forms 1099) pertaining to

subcontractor payments. The subcontractors who received large payments wereidentified and again transcripts were requested to determine if they filed Federal andState tax returns. We selected subcontractors that were filing employment tax returnsand also subcontractors that were not filing either income tax returns or employment

tax returns. During the classification process and the examination process, the groupidentified audit issues which appeared to be common within this industry. Thefollowing is a list of the audit areas that were identified:

1. There were large numbers of nonfilers.

2. Circumvention of employment tax liabilities and worker's compensation premiumsby failing to file employment tax returns, paying wages in cash, and classifying all

payments to workers as subcontractor payments.

3. Employees in this industry are issued Forms 1099 for the above reasons. These

individuals offset their Form 1099 income with expenses -- either paid by them or



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their employer, and subsequently qualify for a earned income credit.

4. Sums of large amounts of income. Internal control is usually poor and leads tounderreporting of income earned from Federal and State agencies, from othercontractors, private companies, or other unrelated business activities.

5. Poor accounting records lead to unsubstantiated expenses. Reforestationcontractors contend that they do not have the expertise to maintain quality books

and records.

6. Returns are being prepared by unlicensed preparers. A preparer reported that he

was being paid for bookkeeping services, not for preparing tax returns, and,therefore, was not required to sign the returns.

SUGGESTED SEQUENCE OF SELECTING CONTRACTORS FOR EXAMINATION

Step 1: Identifying the Prime Contractor

Reforestation contractors working in Oregon are required to obtain a Farm/LaborContractor's License. To secure a listing of licensed Oregon contractors you need to

contact the State of Oregon, Bureau of Labor and Industries, Wage and HourDivision. Oregon is the only known state that requires the contractors to have alicense; however, the Bureau of Labor and Industries in your state will be able to give

you more information on their policies.

Another possible resource for locating reforestation contractors is PSPB or the

Department of Revenue in your state. PSPB and the Department of Revenue have the

capability of running a listing of returns with specific Principle Industry ActivityCodes, (PIA Codes). This may be something that your Disclosure Officer can secure

for your area. Finally, you may be able to request a list of contractors from the ForestService or the Bureau of Land Management. These agencies are required to maintain

a current mailing list of contractors who wish to receive the current announcements of solicitations. Chapter 2 of this handbook, lists addresses, and telephone numbers of Oregon and Washington regulatory and licensing offices where you can secure

information about reforestation contractors.

Step 2: Selecting Second-tier Contractors for Examination

While completing the expanded "package audit" the examiner should concentrate onthose subcontractors with the highest dollar volume. A good starting point is to

review the Forms 1099. In addition, the disbursements journal should be reviewed forother large volume contractors who were not issued a Form 1099, since, 1) the primecontractor may not be issuing a Form 1099 to all subcontractors, and 2) Forms 1099



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are not required to be issued to corporations, and contractors are sometimes organizedas corporations to circumvent the Form 1099 filing requirements.

Step 3: Identifying Disbursements to the Selected Subcontractors

In preparation for reviewing the key documents (canceled checks), disbursementsmade to the subcontractors selected in Step 2 must be identified by check number,date, and amount. It has been our experience that the contractors do not maintain

summaries of their cash disbursement journal so it will be helpful to create a data baseof payments made to individuals and the checks issued to cash. This information willbe invaluable for the following reasons:

1. The list will give you a starting point when analyzing a subcontractor's bank deposits since the contractor may be cashing payments received from the prime

contractor at the prime contractor's bank.

2. Prime contractors may be issuing checks to cash and paying the subcontractors incash.

3. The prime contractor may file a Form 1099, but exclude certain payments made tothe subcontractor.

Step 4: Inspect Canceled Checks

The next step is to pull the checks for each selected contractor and to review theendorsements. The examiner will be looking for checks that were cashed in unusual

ways. For example, they may have been converted to cashier checks, cashed at the

payor's bank, cashed at a check-cashing business, deposited to a bank account locatedin another city, or endorsed to another individual. Because contractors normally

operate as closely held family businesses, with few accounting controls in place, failureto deposit normal business receipts is a good indication that the income is not being

reported for tax purposes.

Step 5: Select Subcontractors for Audit

After completion of Step 4, the examiner will have identified one or more contractorswhose audits will spin-off. He or she would be well advised to request the paymentdetail for these contractors for the subsequent year as well. Requesting information in

the early stages is advisable since it may become increasingly difficult to obtaindocuments as the audit progresses.



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Step 6: Secure Documents for the Subcontractor File

The information to be accumulated for each contractor that will be spun-off should

include as much of the following as is available:

1. Forms 1099

2. Front and back of all checks issued to the subcontractor

3. Any identification information that the prime contractor may have on thesubcontractor, such as past and current addresses, telephone numbers, business

names, invoices, and social security numbers.

Step 7: Other Sources of Information for Locating Subcontractors

If the address or social security number retained by the prime contractor does not help

you in locating the subcontractor, you can call the Corporate Commissioner to obtainthe address of the business and the names and addresses of the registrants. We have

found that it is common for individuals to register an assumed business name with theCorporate Commissioner and give the name and address of several registrants. (Forinformation on Oregon businesses you can call (503) 378-4166). The Department of

Insurance and Finance can be a helpful source for locating subcontractors. Thisagency maintains a list of individuals and businesses who currently have worker'scompensation coverage. If the subcontractor currently has coverage, you can obtain

.his or her home address. The Department of Insurance and Finance can also give youinformation about a business and tell you whether or not the business has registered

for coverage as a partnership, corporation, or as a sole proprietor. (In Oregon you

can call (503) 378-4954). As previously mentioned, the Bureau of Labor andIndustries, Wage and Hour Division will have names and addresses of all licensed

contractors. (In Oregon you may call (503) 378-3292).



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Chapter 2

NATURE OF OPERATIONS

OVERVIEW OF THE INDUSTRY

This MSSP Guide is designed to assist examiners in completing examinations of reforestation contractors. A contractor working in the reforestation industry may

secure service contracts, (pre-commercial thinning and tree planting contracts) from aFederal agency, a State agency, from private companies, or other contractors. Keep in

mind that State and Federal agencies issue several types of service contracts; examplesare fire .fighting, cone collection, tree netting, tree shading, gopher baiting, etc. Atthis time it does not appear that the reforestation-station contractors bid for service

contracts other than tree planting and tree thinning. However, no industry is stagnantand this may be something that contractors may expand into in the near future as they

develop expertise in the reforestation industry. Since the most predominant type of service contract issued by the Federal and State agencies are pre-commercial thinningand tree planting contracts, the scope of this Guide has been limited to reforestationcontracts only.

FEDERAL AND STATE AGENCIES ISSUING REFORESTATION CONTRACTS

The following Federal and State agencies have the .authority to solicit individuals todo pre-commercial thinning and tree planting:

1. The Bureau of Land Management (BLM)

2. The U.S. Department of Agriculture Forest Service

3. The Small Business Administration Section 8A Program (the Small Business

Administration under Federal Equal Opportunity regulations are set up to award,to qualified section 8A contractors, 10 percent of all Forest Service and BLMcontracts. They do not monitor the contracts or make payments. The Forest

Service or BLM continues to perform these services).

4. State agencies, such as The Oregon Department of Agriculture Forest Service and

Oregon Department of General Services.



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PRIVATE COMPANIES ISSUING REFORESTATION CONTRACTS

There are many private companies involved in producing timber products who may

issue tree planting or tree thinning contracts, (that is, lumber mills, sawmills, veneerplants, plywood plants, and in some instances logging companies). Private companies

issue tree planting or thinning contacts to either replant or maintain their own timberlands or to comply with the terms of a Federal or State contract. Certain states .havelegal requirements requiring all forest lands be replanted; these laws may cover bothpublic and private lands. Private companies who purchase timber stands from Federal

and State agencies agree to replant the land after harvesting the timber. There is apattern of these private contractors employing the reforestation contractors on a

regular basis.

Copies of contracts issued by private companies were requested; a review of these

private contracts did not reveal any significant differences from those issued by theFederal and State agencies. The contracts reviewed by the group were written

agreements between the company and the contractor and specify that the reforestationcontractors will follow the applicable State and Federal laws while they are engaged toplant trees or for tree thinning.

TYPES OF CONTRACTS

This report concentrates on the requirements of securing contracts from the Federaland State agencies for two reasons: First, there are more contracts issued by the State

and Federal agencies than by private companies. And secondly, it is more difficult toobtain information from private companies since this information is not public record

as is the case with the Federal and State agencies.

Federal procurement regulations allow Federal agencies to solicit bids from

prospective contractors for three major types of contracts: Service, supply, andconstruction. As previously mentioned, only service contracts are discussed sincepre-commercial thinning contracts and tree planting contracts fall in this area.

Services are considered to be work that requires the direct engagement of thecontractor's labor with the goal of performing an identifiable task rather than to furnish

an end item of supply. This would include tree planting, tree thinning, cone collection,brush piling, etc. However, the term "service" excludes work done by theconstruction trades. (The group members have not researched either construction or

supply contracts).

The State and Federal agencies have further divided thinning contracts into: 1)

pre-commercial thinning contracts and 2) commercial thinning contracts. It becomesimportant to understand the difference between the two types of thinning contracts



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since it will enable you to be more successful in obtaining third party information.Probably the most important thing to remember is that these contracts do not fall

under the same Federal Regulations nor will one contractor be qualified to work bothtypes of contracts.

Pre-commercial thinning contracts are issued by the Forest Service to thin youngforests (10 to 20 years of age). The young forests are thinned to cull undesirabletrees, (such as oak, pine, and damaged firs) to give the remaining trees more room to

grow.

Commercial thinning contracts, on the other hand, are .issued by the Forest Service to

selectively harvest .mature trees. The Forest Service negotiates commercial .contractshave certain lands selectively harvested versus clear cut, as in the case of standingtimber sales. Commercial thinning contracts are not considered to be reforestation

contracts.

GENERAL REQUIREMENTS FOR STATE AND FEDERAL AGENCIES

Pre-commercial thinning contracts or tree planting contracts fall under State and

Federal regulations. To illustrate, in the State of Oregon, to become a primecontractor the individual must provide the following:

1. A valid Farm/Labor Contractor's License (applies in Oregon; check to see if thereare similar requirements in your state).

2. Verification of Worker's Compensation coverage.

3. A Bid Bond or Performance Bond.

4. Agreement, under penalties of perjury, to follow all State and Federal labor laws.

Federal and State contracts are guided by a series of laws and are enforced by severalagencies. The Bureau of Land Management, the U.S. Department of AgricultureForest Service, the Small Business Administration Section 8A Program, and the

Oregon Department of Agriculture Forest Service enforce the operational aspects of the contracts guided by various Federal procurement regulations. Other Federalagencies, such as the Department of Labor and the Immigration & Naturalization

Service, enforce regulations in relation to wages and the legal status of workers. Stateagencies are also involved. The state of Oregon's Bureau of Labor & Industry and the

Department of Insurance and Finance enforce or monitor regulations governinglicensing and Worker's Compensation coverage.



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State of Oregon - Bureau of Labor and Industries - Wage and Hour Division - Oregon

Farm/Labor Contractor"s License

All solicitations for reforestation contracts (including, but not limited to, tree planting,brush clearing, and pre-commercial tree thinning, prescribed burn services, or

contracts for cultivation of a crop) will contain the requirement for the Farm/LaborContractor's Certification of Registration. A Notice to Proceed will not be issuedwithout positive proof of the certification. Application for registration numbers would

be made to the Department of Labor office.

The contractors are required to provide a bond before a Farm/Labor Contractor's

License will be issued and provide a certificate of worker's compensation coverage.The cost of the license is $100.

Beginning July 1989, Wage and Hour Division is requiring a $10,000 bond, up from$5,000, and the contractors must take an examination before their license will be

renewed. The examination pertains to the laws in various areas, (such as Worker'sCompensation, Occupational Safety and Health Administration, Wage & Hour, andForestry).

Once the contractor has received a license and begins working reforestation contracts,he or she must file a certified payroll every 35 days with the Bureau of Labor and

Industries, Wage and Hour Division (BOLI). The certified payrolls will list employeenames, their gross wages, and the amount withheld for taxes. BOLI uses the certifiedpayrolls as a measurement device to determine whether or not contractors are

complying with State wage and hour laws.

BOLI is looking for contractors who do not pay wages, since the failure to pay wagesis grounds for withdrawing the Farm/Labor Contractor's License. All recordsmaintained by BOLI are public. BOLI has changed the expiration date of theFarm/Labor Contractor's License to spread their workload. In prior years all licenses

expired on January 31. Currently, the expiration date is determined as follows:

1. The date of incorporation is the renewal date for all corporations.

2. The date of birth of the oldest partner will be the renewal date of the partnership.

All partners in a partnership must now have a $10,000 bond. A lessor aggregate bondcan be negotiated if the contractor has a clean record. The contractors are allowed a

25-percent reduction in the aggregate amount due each year their record stays clean.The minimum bond they would be required to provide would be $10,000 or 25percent of the total aggregate, whichever is larger.



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Example 1

The partnership has five partners. The total bonding due would be: 5x $10,000 or $50,000. With a clean record it would be reduced to:$50,000 x 75 percent or $37,500. The next year with a clean record it

would be reduced to: $50,000 x 50 percent or $25,000. The .nextyear with a clean record it would be reduced to: $50,000 x 25 percentor $12,500. This would the lowest amount the partnership would be

allowed to pay. If 25 percent of the aggregate had equaled less than$10,000 then the partnership would be required to pay $10,00.

A corporation will have to provide a bond for the majority shareholder and any otheractive stockholder in the corporation. The same rules apply to the aggregation andreduction as with partnerships.

The prime contractors and all first-tier subcontractors shall be required to obtain and

maintain a Farm/Labor Contractor's License. Contractors not having a current licensewill be required to furnish evidence of having obtained such license within 10 daysafter receipt of written notification of the contract award. Failure to obtain, keep, or

maintain a current license during the term of this contract or the extension thereof shallbe basis for termination or default.

Contractors living in Oregon may bid and receive contracts in other states, (that is,Northern California, Washington, Idaho, etc.). Oregon contractors are not required tohave or maintain an Oregon Farm/Labor Contractor's License to work contracts

outside of Oregon. However, Oregon contractors who have lost their license normallywill continue working in the industry although they now are required to work outside

of Oregon.

The Forest Service, the Small Business Administration, and the Bureau of LandManagement do not have the authority to ensure that the first-tier subcontractors have

a valid license. This causes concern because it allows the prime contractors to useunlicensed subcontractors. The system is not fail proof and Oregon contractors canfind ways of hiring unlicensed contractors within the law. You could find an Oregon

contractor paying subcontractor payments to a first-tier subcontractor who lives inOregon but does not have a license. For example, a first-tier sub-contractor, whosetax home is in Oregon, works for an Oregon contractor in California. Whether or not

the Federal agencies are able to enforce the licensing requirement at the first-tiersubcontractor level depends on their working relationship with the prime contractor.

Another important point to remember is that the State of Oregon, Bureau of Labor &Industries, Wage and Hour Division has no authority to enforce the hourly wage rates

set by the U.S. Department of Labor. The State of Oregon has no set amount that



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must be paid to reforestation workers, with the exception of the minimum hourly wagerate. According to BOLI, they have .tried to set a standard of $6 to $7 per hour for

employees in this industry.

Workers’ Compensation Carrier - SAIF Corporation

According to the terms of the Federal and State pre-commercial thinning contracts andthe tree planting contracts, all prime contractors must carry worker's compensation on

their employees. SAIF requires that the prime contractor carry worker's compensationcoverage regardless of whether or not their subcontractors are covered.

SAIF is only one of the companies providing worker's compensation in the State of Oregon. There are approximately 250 worker's compensation insurance companiescovering the state. There are six large companies. The three main ones which would

probably cover contractors in the reforestation industry are: SAIF, Liberty Northwest,and Employers of Wausau. The Oregon Worker's Compensation rates range from $51

to $34 per every $100 of payroll. This amount varies by year and will go up or downdepending on the contractor's work record. According to SAIF, they have hadinstances where contractors in the assigned risk pool will pay $100 for every $100 of

payroll. If you want to check to see if a contractor is currently covered by SAIF youcan call (503) 373-8000. SAIF is authorized to release some information without .asubpoena. They can tell us if a contractor is insured, how much the contractor has

paid in insurance premiums, how many days were worked, and the amount of payrollreported. We can subpoena their audit reports, correspondence or any claims filedagainst a contractor.

State of Oregon - Worker’s Compensation

The Department of Insurance and Finance maintains a listing of employers whocurrently have worker's compensation as well as their coverage history. You can callthe Employer Index at (503) 378-5540 to find out if any employer is currently

covered, if they had coverage in prior years, and when their coverage was terminated.The Department of Insurance and Finance will only have information on employerswho are required to have coverage. Employers are required to carry worker's

compensation if they pay an employee $200 per month.

Reforestation contractors frequently change their business names and the registrants of

the business. There could be several reasons why the contractors change the businessname or registrants, including attempts to circumvent payment of Worker's

Compensation. In Oregon, wage payments made to the owners of the business, (thatis, the partners in a partnership, or officers of a corporation) are exempt from worker'scompensation coverage.



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The Department of Insurance and Finance can tell you if an individual or a business isregistered with them as a partnership, corporation, or a sole proprietor. This

information may be helpful in determining whether or not all required returns werefiled.

The files kept by the Department of Insurance and Finance are public records.However, the Department will not have a file on an employer unless there has been acomplaint filed against him or her. If an employee makes a complaint against an

employer, Worker's Compensation will send out a Field Investigator.

Worker's Compensation is not concerned about the subcontractor issue because they

can hold the prime contractor liable. In fact, they can go back to any State agency orprivate company who offered the contract, if the prime contractor did not provideworker's compensation. This has been true since 1979. As of July 1989, Worker's

Compensation can now go back to any entity who issued the contract with theexception of the Federal Government.

Oregon contractors working in Washington must carry Washington worker'scompensation if: 1) the contract exceeds 30 days, or 2) they hire Washington

residents.

State Regulatory and Licensing Offices

The following is a list of state regulatory and licensing offices from which third partyinformation can be obtained.



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OREGON STATE WASHINGTON STATE

1. Register Business/Incorporate/Assume Business Name:

Secretary of State Dept. LicensingCorporate Division Services158 12 Street, NE 405 Black Lake Blvd.th

Salem, OR 97310-0210 Olympia, WA 98504PH: (503) 378-4166 PH: (206) 753-4401

2. Tax Records:

Department of Revenue Department of Revenue966 Central Street, NE Mail Stop AX-02Salem, OR 97301 Olympia, WA 98504

PH: (503) 945-8091 PH: (206) 753-5525

3. Compensation Insurance:Dept. of Insurance & Finance Dept. of Labor &

Worker’s Compensation IndustryDivision 905 Plum Street, SE21 Labor & Industries Bldg. Olympia, WA 89504

Salem, OR 97301 PH: (206) 956-4817PH: (503) 452-0288

4. Farm/Forest Labor Contractor License:

Bureau of Labor & Industry Dept. of Labor &

Wage & Hour Division IndustryLicensing Unit ESAC Division

1400 SW 5 , Room 305 925 Plum Street, SEth

Portland, OR 97201 Olympia, WAPH: (503) 731-4074 PH: (206) 956-5315

State of Oregon

Bureau of Labor andIndustries3865 Wolverine, NE Rm. E-1

Salem, OR 97303PH: (503) 378-3292



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Bonding Requirements

Contractors are required to provide bid bonds and performance bonds in certaininstances. The bond can be either a surety bond underwritten by a bonding companyor the individual can put up cash or other liquid assets such as stocks and securities.

The cash or other liquid assets would be placed in a escrow account and would beavailable for payment of any unpaid wages due the employees. The interest incomeearned from the escrow account belongs to the contractor. The performance bond is

held in escrow for 150 days after the job is complete. If no complaints are filed, thebond is released.

Currently, Federal agencies are only requiring bonding on service contracts and treeplanting contracts over $25,000. The State of Oregon requires a bid bond on all bidsover $15,000.

Laws Administered by U.S. Department of Labor

The contractors are expected to comply with a number of laws that are administeredby the Department of Labor .n the performance of a Federal contract. The following

is a brief explanation of the more common laws with which contractors are expectedto comply during the performance of the contracts:

1. Service Contract Act of 1965, as amended: Wages Rates and Fringe Benefits forService Employees.

This law is applicable to employees working on Federal contracts which areprincipally for services, as follows:

Contracts over $2,500 -- Payment of not less than wage rates and fringe benefitsfound by the Department of Labor to be prevailing in the locality or, in certaincases, wages rates, and fringe benefits contained in a predecessor contractor's

collective bargaining agreement as provided in a wage determination, included inthe contract. This law also contains record keeping and safety and healthrequirements. Exhibit 2-2 contains a copy of a Wage Determination letter which is

enclosed in each contract solicitation package.

Contracts of $2,500 or less -- Payment of not less than the minimum wage

provided in Section 6(a)(1) of the Fair Labor Standards Act.

Administered by: Employment Standards Administration, Wage-Hour Division(Safety and Health provisions are administered by the Occupational Safety andHealth Administration (OSHA)).



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2. Contact Work Hours and Safety Standards Act: Overtime Pay: Safety and HealthRequirements.

This law and its implementing regulations require that all laborers and mechanicsemployed by contractors or subcontractors in the performance of most Federal

service contracts exceeding $2,500 be paid overtime compensation at a rate of notless than one and one-half times their basic rate of pay for all hours worked inexcess of 40 in a work week. The act also includes safety and health provisions.

Administered by: Employment Standards Administration, Wage-Hour Division(Safety and Health provisions are administered by the Occupational Safety and

Health Administration (OSHA)).

3. Migrant and Seasonal Agricultural Worker Protection Act: Labor Standards

Protection for Migrant and Seasonal Agricultural Workers.

This law requires farm labor and forestry contractors, agricultural employers, andagricultural associations to observe certain labor standards when employingmigrant and seasonal agricultural workers, unless exemptions apply. Only farm

labor and forestry contractors are required to register with the Department of Labor. Worker protection includes: Vehicle and housing safety requirements;disclosure of wages, hours, and working conditions, maintenance of prescribed

records; and itemized information concerning pay and withholding from earnings.

Administered by: Employment Standards Administration, Wage-Hour Division.

4. Federal Labor Law Enforcement: For information on any of the previously listed

laws administered by the U.S. Department of Labor, you can contact the officeslisted below:

PORTLAND AREA SEATTLE AREA U.S.

Department of Labor U.S. Department LaborESA, Wage-Hour Division ESA, Wage-Hour Division540 New Federal Building Room 1060

1220 SW Third Avenue Federal OfficePortland, Oregon 97204 909 First AvenuePH: (503) 326-3052 Seattle, Washington

PH: (206) 442-4482



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Chapter 3

CONTRACTS IN GENERAL

MAILING LIST

Contractors wishing to secure reforestation contracts must submit their names to the

Forest Service and the Bureau of Land Management to be placed on a mailing list.Once the contractors are on the mailing list they are notified of the contracts beingoffered to the general public. The Federal Government recommends that contractors

subscribe to the "Commerce Business Daily" if they want notification of solicitations inexcess of $25,000, since this publication contains Government-wide procurementopportunities.

The Federal agencies maintain a separate mailing list used to notify the contractors of

contracts under $25,000 which are being offered. Contractors wishing to be notifiedof contracts under $25,000 must submit their names to the local offices of eachagency. To secure information on contracts under $25,000, you will need to contact

each of the Forest Service offices or BLM offices in your State.

The same is true with the State of Oregon Forest Service. General Services issues

contracts in excess of $15,000, and Contracting Officials are granted the authority toissue contracts under $15,000. The State also maintains two separate mailing lists;one is maintained by General Services and the other is maintained by the Contracting

Officials.

SOLICITATION METHODS

1. Invitation for Bids (IFB)

A solicitation method which requires a prospective contractor to submit a sealedbid. The bids are then opened at a public bid opening. Bids are considered a firmoffer and cannot simply be withdrawn after the opening. Contracts are awarded .

to the lowest bidder.

IFB is used for all solicitations in excess of $25,000, and constitute the largest

percentage of the contracts awarded.

2. Request for Proposal (RFP)

A solicitation method used with competitive negotiation for procurement. If you

are making an offer in response to a RFP, you may withdraw your offer at any



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time before the contract is awarded. There is no public bid opening with thissolicitation method.

RFP is normally used for solicitations under $25,000. The Contracting Officialwill determine whether on not to use either a RFP or RFQ (below).

3. Request for Quotations (RFQ)

A solicitation method that includes a request for price information. An RFQ maybe either oral or written. If written quotes are required, no public opening is held.Quotes are reviewed and awards are made based on the quote which will be most

advantageous to the Government, the lowest bid.

CONTRACT CONTENTS

The Federal agencies follow applicable Federal regulations when developing the

schedules and general provisions of any pre-commercial thinning or tree plantingcontract. Therefore, you will find specific information contained within all contractsolicitation packages. The following is a typical table of contents from a contract

solicitation package:

Section A _________ Solicitation, Offer and Award

Section B _________ Continuation SheetSection C _________ Specifications Tree PlantingSection D _________ Inspection/Acceptance/Payment

Section E _________ Inspection/Acceptance/PaymentSection F _________ Delivery/Performance Tree Planting

Section G _________ Contract AdministrationSection H _________ Special Contract RequirementsSection I _________ Service Contract Clauses*Section J _________ Wage Determination and Fringe Benefits

*Section K _________ Representations, Certifications, and Other Statements of Offerors

*Section L _________ Instructions, Conditions, Notice to Offer

The sections marked with the "*" will contain information that may be helpful incompleting your audit. In these sections you will be able to find social security

numbers, employer identification numbers, addresses, entity information, bondingcompany information, the taxpayer's average annual receipts for the prior 3 fiscal

years, if applicable, and names, addresses, EIN, and labor license numbers of reportedparent companies.





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At the pre-work conference, the contractor shall provide to the COR a written "work progress plan" which details his or her work force and his or her proposed schedulefor completion of the work, within the contract performance time. The work schedule

will be used as a guide to measure the contractor's performance as well as to calculatesuch things as the rate of tree delivery to meet the contractor's needs to ensure thetimely completion of the contract. If the contractor's progress falls behind 20 percent

of the established work schedule, the contractor's right to proceed may be terminated

for default unless satisfactory progress is attained within 3 working days of the receiptof the written notice of deficient performance.

The COR is the on-the-ground administrator for the Contract Official. The COR is

authorized to clarify technical requirements, and to review and approve work withinthe scope of the performance of the contract. The COR has the authority to designatea Project Inspector to determine whether or not the contractor has complied with the

technical specifications, drawings, work schedule, and labor provisions at the work site.

At the pre-work conference, the Contract Official or the COR will make sure that each

contractor understands, among other things, that the individuals performing the work are employees and are governed by statutory and regulatory laws pertaining to the

reforestation industry. Some Contract Officials or CORs will have a specialchecksheet for the pre-work conference; you will find a copy of an actual checksheetused by a Contract Official, see Exhibit 3-1. This checksheet may be helpful in

convincing the prime contractor that his or her workers are employees and do notqualify as subcontractors. Please refer to the employee section for further discussionof employees and laws applicable to the reforestation industry.

PAYMENTS

All vendor payments of $25,000 or more must be made through the Treasury FinancialCommunication System (a wire transfer system). Beginning sometime after December

31, 1988, and before December 31, 1989, contractors successful in obtaining contractswere required to supply certain financial institution information, (bank accountnumbers), to the Federal Government so their contract payments could be deposited

directly to their bank account.

Contractors normally receive more than one payment during the performance time of

the contract. According to Contract Officials, the contractors are paid approximatelyevery 2 weeks and the amount of the payment is based on the work done, determinedby the percentage of completion. However, it takes approximately a month from the

time the contractor begins work on a contract until he or she receives the firstpayment.

Keep in mind, the duration of a contract is relatively short. In other words, once thecontract is awarded it is usually started within 2 to 3 weeks and completed withinanother 2 to 4 weeks, depending on the size of the job. The Forest Service keeps the

duration of the contracts short since they are concerned about planting the trees at a



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time which will ensure the highest rate of survival among the new seedlings.

You may find that the contractor has deposited funds into his or her business account

that he or she does not consider to be taxable. Reforestation contractors are able tosecure advances from their bank by assigning the income from the contracts that theyhave been awarded. For a discussion on assignment of income see Chapter 6, of this

audit guide.






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Prework Conference Guide (Service Contract)

PROJECT:_______________________________CONTRACT NO:_____________________

CONTRACTOR:__________________________FOREST:____________________________

COR:_________________________________INSPECTOR___________________________

A prework conference was held at:________________________________________________

and was attended by the following:

Forest Service:

Contractor:

_____________________________presided over the meeting and the following items were

discussed:

FOREST SERVICE ORGANIZATION

A. General

Only the Contracting Officer, the Administrative Contracting Officer (ACO), or Contracting

Officer’s Representative (COR) have authority with respect to this contract. Other Forest Serviceofficials may visit the work site from time to time. However, the Contractor is warned that

payment cannot be made for any costs incurred as a result of a response to an order or instruction

issued by someone other than the Contracting Officer, ACO, or COR. The only exception to thisis the case of a forest fire. While a direct line of communication is always open to the Contracting

Officer, or ACO, all correspondence and other communications should normally be directed to

the COR.

B. Contracting Officer

The Contracting Officer has full authority for the administration of the contract and willpersonally handle all matters beyond the authority of the COR or ACO.

C. Administrative Contracting OfficerAn ACO has/has not been designated for the contract. The ACO is authorized to take all actions

necessary for administration of the contract within applicable laws and regulations, except for

final decisions under the Disputes Clause, termination for default or convenience, and final

acceptance of the services rendered. This includes signatory authority for Contract Modificationsup to the limits stated in the letter of designation.

R6-FS-6300--61 (9/84)

Exhibit 3-1 (1 of 6)

Checksheet Used by Contract Official



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D. Contracting Officer’s Representative

The COR is the on site contract administrator for the Contracting Officer, whose duties andresponsibilities are defined in the letter of designation. Generally, this includes fill authority

for the day-to-day administration of the contract, except for matters pertaining to changes incontract price and time.

E. Inspector(s)The COR may designate Inspectors who are responsible for checking Contractor’s

compliance with the technical specifications, work schedule, and labor standards of the

contract. Contractor will receive a copy of Insepctor Designation Letter(s). Copies willbe/were distributed.

PERFORMANCE

F. Contract Time

Contract time specified for this project is_________________calendar days. Contract timewill be accounted for on a claendar day basis, including Saturdays, Sundays, and holidays,

and will run continuously from the effective date of the Notice toProceed to the date of

completion of the work, unless work is suspended by the COR. Work suspension may bepartial or total. Normally, the count of contract time will cease when work is totally

suspended. During period of partial suspension, count of contract time will continue,

however, an appropriate adjustment will be made in the contract time. Notice to Proceedwas/will be effective____________________.

G. Progress ScheduleA Proposed Progress Schedule, showing the proposed sequence of work and the anticipated

date of completion, was prepared on form r6-6320-18 and copies were distributed/are

attached:or,

The COR and Contractor agreed to use a daily rate of production using the following

formula in lieu of preparing form R6-6320-18:

Total Contract Units = Units Daily Production

Total Contract Days

Daily Production shall be___________________units (acres, miles, etc.)

ADMINISTRATION

H. SuperintendenceIn the absence of the contractor, there shall be an authorized representative of the Contractor

on the project at all times when work is in progress. Contractor submitted letter designating

representative(s), and the extent of his/her/their authority. Copies were distributed/areattached.

I. Permists and Reponsibilities for the Work The Contractor is reponsible for obtaining any applicable licenses and permits and must

comply with all Federal, State, and local regulations, laws and codes.




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J. Camping Permits

The Contractor does/does not intend to camp on National Forest lands. Forest Service permits willspecify restrictions regarding campsites and sanitary provisions. Combustible refuse, resulting fromlunches, etc., may be burned if authorized by District Ranger. All noncombustible materials, cans

bottles, etc., shall be removed from Forest land.

K. Payments

Progress payments will be made monthly as the work proceeds, or at more frequent intervals, if

approved by the Contracting Officer. Progress payments will be initiated by the COR on the ______day of each month.

Following completion and acceptance of the work, the Contractor shall be paid upon presentation of aproperly executed voucher and a release of all claims agains the Government, other than claims in

stated amounts specifically excepted by the Contractor on the release form.

L. Fire Prevention and Control

Specific fire prevention measures were briefly/thoroughly discussed including fire period,

precautionary measures, and fire tools. The COR is responsible for obtaining any fire requirementwaivers, authorized by the District Ranger.

CONTRACT CLAUSES

M. Changes

The Contracting Officer may, by writeen Change Order, make any change within the general scope of the contract, including but not limited to: changes in specifications; in method or manner of

performance of the work; in Government-furnished facilities, equipment, materials, services or site;

and direct acceleration in the performance of the work.

N. DisputesThis clause prescribed definite procedures to be followed in cases of disputes arising between the

Contractor and the Government. Except as the parties may other wise agree, pending final resolution

of a claim, the Contractor shall proceed diligently witht he performance of the contract and inaccordance with the Contracting Officer’s decision.

O. Termination for Default; Damages for Delay; Time ExtensionsIf the Contractor refuses or fails to prosecute the work with such diligence as will ensure completion

within the time specified, the Government may terminate the Contractor’s right to proceed. Whether

or not the Contractor’s right to proceed is terminated, the Contractor shall be liable for any damage tothe Gevernment resulting from the refusal or failure to complete the work within the specified time,

P. Property and Personal DamagesThe Contractor shall use every precaution necessary to prevent damage to public and private

property. The Contractor shall be reponsible for all damage to property and persons that occur as a

result of his/her or his/her agent’s or employee’s fault or negligence.




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LABOR STANDARDS PROVISIONS (Statutory and regulatory requirements pertaining to labor)

Q. Equal OpportunityThe Contractor agrees that he/she will not discriminate against any employee or applicant for

employment because of race, color, religion, sex or national origin and will take affirmative action to

ensure that applicants are employed, and are treated during employment, without regard to race,color, religion, sex or national origin.

In the event of noncompliance with the Equal Opportunity provisions, the contract may be canceled,terninated or suspended, in whole or in part, and the Contractor may be declared ineligible for

further Goverment contracts. The Contractor must include the Equal Opportunity provisions in

every subcontract. The Equal Employment Opportunity Poster will be/was given to the Contractor,with instructions to post in conspicuous places, available to all employees and applicants for

employment.

R. Service Contract Act of 1965

All service employees employed in the performance of the contract shall be paid not less than the

minimum monetary wage and shall be furnished fringe benefits in accordance witht he WageDetermination Decision.

The Wage Determination Decision, along with the Wage Rate Poster WH-1313, Notice toEmployees working on Government Contracts, shall be posted in a location where it may be seen by

all employees performing on the contract.

The Contractor shall make and maintain, for three years from completion of the work, records of

each employee’s name, address, work classification, wages paid and fringe benefits provided, hours

worked and any deductions from compensation.

S. Contract Work Hours and Safety Standards ActLaborers, mechanics, apprentices, trainees, watchpersons and guards shall be paid at least one and

on-half times their basic rate of pay for all hours worked in excess of 8 hours a day or 40 hours a

week, whichever is the greater number of overtime hours.

T. Safety and Sanitary Working Conditions

The Contractor shall not permit the services called for by the contract to be performed insurroundings or under working conditions, under the Contractor’s control, which are unsanitary or

hazardous or dangerous to the health or safety of employees engaged in the work. The Safety and

Health Protection on the Job poster was given to the Contractor with instructions to post at the work site.




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U. Federal Procurement Regulations

1. Part I, Section C of the contract contains both the general and technical specifications.2. Part I, Section E deals with inspection and acceptance. Of special note is Clause 52.246-4,

Inspection of Services, Fixed Price. This clause provides, among other things, that the

contractor will provide and maintain an inspection system and records acceptable to the

Government covering services under this contract.3. Part I, Section H contains special contract requirements.

4. Part I, Section I contains clauses incorporated by reference. The full text is available in the

Federal Register. Complete copies can be purchased from the Superintendent of Documents,Government Printing Offices, Washington, DC 20402. All applicable referenced clauses are a

part of this contract.

Other Items Discussed

The specifications and inspection procedures of this contract were jointly reviewed by the Contractor andthe COR.

_______________________________________________ Date_______________________

_________________________________________________ Date_______________________(Contracting Officer’s Representative)




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EXPERIENCE QUESTIONNAIRE

1. How many years experience as a Prime Contractor do you have? If this is your first contract as a

Prime Contractor, what experience have you had either as a subcontractor or employee?

2. List your recent contract experience relating to reforestation?

Contract Amt Type of Project Date Completed Contact Person

3. What contracts do you currently have?

4. How many personnel will be assigned to this project?

a. Who will be your forperson(s) and what is their experience?

b. Who will be responsible for self-inspection and what are their qualifications?

5. In the event you fail to meet progress, how will you correct this problem?

6. Are there any problems you may foresee with this contract? If so, explain.

7. Are you aware of the applicable Service Contract Act wage rate for this contract?

8. Have you ever defaulted on a reforestation project? If so, explain.

9. Did you visit the job site or talk with anyone regarding the project?

10. A copy of the bid abstract listing the awarded contractors has been sent to the State of Oregon’s

Workmen’s Compensation Bureau and U.S. Department of Immigration. You may be contacted by them

______________________________

Contractor

______________________________

Title

______________________________ ____________________

Solicitation No. Contract No.

______________________________

Date




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Chapter 4

PRE-AUDIT ANALYSIS

ANALYSIS OF INFORMATION ACCUMULATED BEFORE STARTING THE AUDIT

Returns assigned to you will normally contain, at the most, charge-out labels, atranscript, and an IRP transcript. When you are assigned a reforestation contractor

and the case file does not contain an IRP transcript, order one as soon as possible.You may find that the contractor has several sources of income that he or she hasfailed to report. However, do not use the IRP document as your only income probe

since it is most likely that this document is only partially complete at best. Hopefully,the following discussion of the IRP transcript will give you a better understanding of the Form 1099 reporting problems of this industry.

IRP Transcripts

"Income" is the audit issue which benefits most from accumulating the types of information/documents that are discussed in this chapter. Most commonly, an

examiner has little information in the file before the first appointment with thetaxpayer. Items that have been accumulated at this stage of the audit are those thathave been generated by the Service Center. Of these, only the IRP transcript has the

potential of assisting in the income audit but, as known by most examiners, thesedocuments rarely give a complete listing of an entity's taxable sources of income.However, the IRP transcripts are a good starting point in the income audit.

We found three major problems with how the Federal agencies were handling the filing

of their Forms 1099. First, the Federal employees were not sure who should receive aForm 1099; one agency reported that they were not issuing Forms 1099 topartnerships. Secondly, the Federal agencies issuing the contracts were not assumingresponsibility to see that a Form 1099 was issued. The Form 1099 was only issued if

the proper box was indicated on the payment voucher by the individual requesting thepayment. Finally, there was a question as to who was responsible for seeing that thetaxpayer identification numbers (TIN's) were provided. According to the company

who issued the check, if the identification number was not included on the paymentvoucher, then a Form 1099 would not be issued for that payment.

Whether or not the Forms 1099 are complete is only one of the problems. The secondidentified problem is whether or not the Form 1099 is correct. During our

examination of one reforestation contractor, we found that he issued 35 Forms 1099.Of the Forms 1099 issued, we found that: 1) Nine Forms 1099 matched the name andSSN shown on AIMS and 2) 26 of the Forms 1099 had either the wrong SSN or no

data was available on AIMS. The group researched Forms 1099 filed by two other



4-2

contractors and found that some contractors appear to be filing erroneous Forms 1099to circumvent the Form 1099 matching program. Even though the Forms 1099 may

not be 100 percent correct, they are very useful and may identify sources of incomewhich cannot be found using other audit procedures. For example, a contractor'saccountant did a bank deposit analysis to determine his income. The bank deposit

analysis appeared to be complete and show .all sources of income. However, afterreceiving an IRP transcript we were able to identify income received from unreportedsources which were not deposited by the contractor.

DOCUMENT REQUEST

1. Request the normal documents

At a minimum, the following should be requested: All books and records,

adjusting journal entries, accountant's workpapers, bank statements for businessand personal accounts, savings account and credit line statements, duplicate

deposit slips, a detailed depreciation schedule, Forms 1099 received, Forms W-2and 1099 filed by the contractor, copies of employment tax returns (beginningwith the year under audit to the most current returns filed), and copies of invoices

retained.

2. Request additional documents

a. Request the prior and subsequent year returns. A comparative analysis ishelpful in identifying large or unusual items.

b. Request a listing of all contracts worked by the taxpayer during the year and a

listing of the contracts in progress at yearend.

c. Request a tour of the business. This may be the only time you will be able toinspect the business premise in order to determine if the assets claimed on the

return exist and are reasonable.

d. Request that the initial interview be held when the taxpayer(s) can be present.

The initial interview may be the only time that you will be able to talk to thetaxpayer.

During your pre-audit you may find other items that appear to be unreasonable.Be sure to include these items on the document request. Remember that it is

important to make the document request as complete as possible since it becomesincreasingly harder to get documents as the audit progresses.



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Chapter 5

INTERVIEW

IMPORTANCE OF THE INTERVIEW

All techniques in this Guide were tested in actual contractor cases. The process of developing a detailed, specific interview plan was found to be a necessity at the

inception of each audit. Sometimes follow-up interviews were needed, as taxpayersaltered their testimony when confronted with examination findings.

The quality of your initial observations and questioning will affect the overall qualityand success of the entire examination, whether or not you have developed third partyinformation or noted other items indicative of non-compliance in your precontact

analysis of the returns.

REVIEW OF THE BASIC TECHNIQUES

The purpose of your interview is to secure from the taxpayer a general financial

picture and familiarize yourself with the business operations and recordkeepingpractices.

Planning is essential to the success of the interview. The interview should be plannedin advance, keeping in mind your objectives and the results of your pre-contactanalysis and your understanding of how this industry should work. If a questionnaire

is used, it should be written specifically for the case in hand. The completed documentshould be a flexible guideline that will assist but not restrict your interview.

Your questioning must be thorough and specific and the responses accurately andcompletely recorded. State questions simply and be certain that they are understood,repeating, and rephrasing if necessary to be sure that the answers are complete and

responsive. Listen carefully to the taxpayer and be sure you understand the answersgiven. Your documentation of the interview should be sufficient to provide anaccurate and retrievable record rather than a transcript of the conversation.

The questions you ask should generally enable you to obtain the background of thetaxpayer and his or her business, to familiarize yourself with the business operation, to

understand the accounting system, to fix responsibility for the records, and to identifysources of income.



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GUIDELINE FOR INTERVIEWING THE CONTRACTORS

When interviewing reforestation contractors, specific emphasis should be given to theareas where non-compliance has proven to be the highest and to those which may, at alater date, be presented as a defense against understatement of income. Since it is not

uncommon to find that some contractors have little or no fluency in English, it isimportant to determine if the assistance of an interpreter will be required or availableprior to the initial appointment.

The understatement of income and failure to pay employment taxes are the primary,but by no means the only, areas of adjustment on the contractors' returns. Defenses

against the understatement of income can be cash hordes, loans, or gifts in the case of non-specific understatement, misunderstanding or poor communication with the returnpreparer; these are the more common in specific understatements.

A partial list of items you may wish to incorporate in your interview plan are given

below. The particular circumstances of an individual case, including data accumulatedprior to the interview, will suggest alterations and additions. It is not intended for useas a pro forma.

SUGGESTED QUESTIONS

Business Operations:

1. How long have you been in the reforestation business?2. How did you get started in the business?

3. Have you operated at other locations or under another assumed business names?

If so, where and what other names?4. Are you a prime contractor or a subcontractor?

5. Who did you work for in the audit years, Federal/state agencies, privatecompanies, or other contractors? List.

6. What types of contracts did you complete: Thinning or tree planting? Other?7. Describe the method you use to determine how much you will bid on any given

contract.

a. What type of expenses are included in your job bid?b. How much profit do you expect to make on a contract?

8. Where there any months that you did not work? When?

9. Are you required to supply transportation for workers?10. What tools do you supply for the workers?11. How are you paid for the work that you do?





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Touring the Premises:

-- A tour of the business premises may not give you all the answers that you will needlater, but it more than likely will give you a good idea of the taxpayer's business

operations. In addition, by requesting the tour of the business you may get theopportunity to talk to the taxpayer, which may not be available to you in thefuture. During the tour of the business you will need to look for the followingtypes of items:

1. If the taxpayer has numerous vehicles on the depreciation schedule, does he or

she have a place to park them at night? There could be personal expenses onthe vehicles.

2. Are there employees' cars parked at the premises during the day?

3. Does the taxpayer have power saws on the business premises?

4. Does the taxpayer have a building on the depreciation schedule? If so, what isits use?



6-1

Chapter 6

ACCOUNTING RECORDS

ACCOUNTING RECORDS IN GENERAL

Reforestation contractors' accounting records can come in any number of forms (thatis, boxes with no audit trail to double-entry systems). Therefore, the examiner should

be prepared to deal with a variety of different accounting systems. It is not uncommonto find poor bookkeeping and recordkeeping practices among prime contractors aswell as subcontractors. You can expect to find situations where ledgers don't balance,

.journal columns don't foot, invoices can't be found, .and personal amounts arededucted as business expenses.

The majority of reforestation contractors operate as sole proprietors and keep theirbooks and records on a calendar year basis. Lack of internal control seems to be a

common element among the reforestation contractors. The contractors frequently arefamily-controlled businesses with one family member performing the duties of keepingthe books and records as well as recording income.

We have found that reforestation contractors use either the cash or accrual method of accounting. This guide is not meant to explain the various methods of accounting

used in the reforestation industry, but rather to assist the examiner in determining whatto look for under the various methods described.

CASH METHOD OF ACCOUNTING

The cash method of accounting is used by most reforestation contractors. Whenexamining a contractor on the cash basis, secure a listing of the contracts workedduring the year. The list should include the contract number, the locations where thework was done, and the amounts and dates of the payments received during the year.

In addition, request a list of contracts in process at the end of the year. Compare thislist to the bank deposits to determine if all money received was deposited upon receipt-- this step will disclose if the contractor has postponed depositing receipts until after

the end of the year or if the contractor's deposit reflects that he or she has taken cashand deposited the remainder.

Generally, cash-basis contractors use their bank deposits to determine total income.However, examination results revealed that it is common for contractors to cash

income checks without depositing the income. In other instances, we found that thecontractors deposited large amounts of cash for which they had no records. The highpotential for large amounts of unreported income allows the examiner an opportunity

to develop quality fraud referrals.



6-2

Question the contractor at the initial interview and determine which method was usedto determine gross receipts reported on the tax return. It is important to secure as

much information as possible early in the examination since the contractor may not bewilling to supply information as the audit progresses.

Also be aware that reforestation contractors, as a normal practice, are able to assignincome to their bank. The bank will advance funds (usually 80 percent of the contractaward letter) to the contractor. The bank then becomes the consignee and the Forest

Service or BLM makes the checks payable to the bank. The bank normally receivesthe checks, pays off the outstanding loans, and deposits the remainder to thecontractor's business account.

Examinations of cash-basis contractors also reflected frequent adjustments for theirdeducting items on their returns for which they have no documentation. Within the

reforestation industry it is common practice for the contractors to use cash to paybusiness expenses. The contractors are often unable to supply proper documentation

for the cash payments. According to the Bureau of Labor and Industries, thecontractors use cash to pay their workers. We have found at least two reasons toexplain why the contractors use cash to pay wages:

1. Illegal aliens perform much of the labor in this industry and they want to be paidwith cash since they do not have Social Security Numbers to obtain bank accounts,

and

2. Contractors want to avoid paying worker's compensation premiums and

employment taxes on wages paid.

ACCRUAL METHOD OF ACCOUNTING

Occasionally you will encounter contractors who are using the accrual method of accounting. If you find contractors who are using the accrual method of accounting,

you will need to find out why they are using this method and when they adopted thismethod. You will want to know if they were required to apply to the Commissioner of the Internal Revenue to change to this method of accounting. Cash-basis contractors

are not allowed to switch to the accrual method without applying for a change of accounting method.

There appear to be few tax advantages or other reasons for reforestation contractorsto use the accrual method of accounting, with the exception of a corporation who has

a valid business reason for a yearend other than December 31. The reforestationindustry is seasonal, which means that the contractors do not have employees workingduring every month of the year. There are some months of the year when weather

conditions do not allow the contractors to have crews in the woods. The weather



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conditions during the month of December usually prevent contractors from working.Therefore, the contractor's accrued expenses should be minimal in December since

wage expenses and the related employment taxes are the contractor's single largestexpense (that is, between 50 and 60 percent of gross income). We have also foundthat the Small Business Administration requires their contractors to file quarterly

financial statements; these financial statements are to be prepared using the accrualmethod of accounting. Therefore, you may find these Section 8A contractors usingthe accrual method of accounting for tax purposes. Make sure the contractors have a

valid election since it is likely that the election was not made.

Inspect accounts payable at the end of the year to determine if the taxpayer has

properly accrued expenses and that the expenses are deductible per IRC section 162.



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Chapter 7

EMPLOYMENT TAXES

EMPLOYEES IN GENERAL

All Federal contracts contain a section that discusses the Contract Service Act and itsrequirements. Information about the Contract Service Act is normally found in

Section J of the solicitation package. Within this section, there will be a WageDetermination Letter issued by the U.S. Department of Labor, Wage and HourDivision. The Wage Determination Letter lists the class of service employees,

minimum hourly wage rates, and fringe benefit payments required to be paid to eachemployee.

Under the Contract Service Act, employers are required to treat each individualworking in the industry as an employee. The only exception is payments made to valid

subcontractors. If the prime contractor pays a subcontractor to complete the job, thesubcontractor becomes responsible for paying wages and employment taxes. Thepayments made to the subcontractors should be large since the subcontractor must pay

employee wages, worker's compensation, and the related employment taxes etc.

Subcontractors must follow the same State and Federal law as the prime contractors.

To be a valid subcontractor, they must provide the following:

1. A valid Farm/Labor Contractor's License (applies in Oregon; check to see if there

are similar requirements in your state).

2. Verification of Worker's Compensation coverage.

3. Proof that they work for more than one prime contractor.

As previously stated, the Contract Official (COR) will discuss the Contract ServiceAct with the contractor during the pre-work conference. They will discuss thecontract requirements for the size of crew to be provided by the contractor; the crew

size may be only three people, but a normal crew size ranges from 5 to 12 employees.It is not uncommon for a contractor to have more than one crew working at a time.Keep this in mind if a contractor tells you that it is industry practice for contractors to

employ only subcontractors.

ISSUES GENERALLY ENCOUNTERED

An examination of a reforestation contractor can result in large employment tax

adjustments. It is common to find wages being paid without consideration of



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employment or income tax withholding. To stay competitive in this industry, thecontractors are looking for ways to pay less in wages, employment taxes and worker's

compensation premiums. The contractors are keeping gross wages as small aspossible which reduces both their employment tax liabilities and their worker'scompensation premiums. Remember that both employment taxes and worker's

compensation premiums are determined based on total wages paid.

The reforestation industry is labor intensive which means that labor costs and the

related employment taxes represent the bulk of the contractor's expenses.Adjustments made in this area can generate substantial tax liabilities. The mostcommon adjustments are reclassification of subcontractors to employees and setting

up additional compensation payments to already existing employees. Substantial taxeswill be generated since the wages paid to individuals seldom exceed FICA and evenFUTA maximums due to the mobility of the work force. The group has found that it

is not uncommon to have employment tax liabilities exceed 40 percent of additionalgross wages before the application of failure to deposit, negligence, or fraud penalties.

During our examinations of reforestation contractors the group has identified thefollowing as possible issue areas:

1. The contractors report all payments to individuals as non-employee compensationpayments (subcontractor payments).

2. The contractors pay their workers in cash and deduct the payments as ordinaryand necessary business expenses, not wages.

3. The contractors deduct the payment of personal expenses for the employees asother business expenses, not as wages.

4. The contractors do not file Forms W-2 or 1099 with the Internal Revenue Service.

Subcontractor Payments

We are finding that the majority of the prime contractors are reporting only

subcontractor payments. If the contractor has only subcontractors then they wouldnot be liable for either FICA or FUTA taxes. However, this is usually not the case.We have found that the prime contractors normally have some employees and some

subcontractors.

When auditing the employee versus subcontractor issue, you need to secure certain

information from the contractors. First, secure a listing of the individuals whoreceived non-employee compensation payments during the examination year. Thegroup found it was easier to create a data base from the contractor's canceled checks



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rather then trying to get this information from the contractor. The data base gave usthe ability to accumulate payments by payee and determine when the payments were

received and how much was received by each individual.

Next, question the contractor on the work performed by each individual. Start with

the suggested questions outlined in Chapter 3, of this Guide and add other questionsthat are relevant. Refer to the training materials “Independent Contractor orEmployee?” Training 3320-102 (Rev 10-96) TPDS 84238I.

Our revenue officer examiner was successful in reclassifying subcontractor paymentsto employee wages. The revenue officer examiner relied heavily on whether or not the

subcontractor held a valid Farm/Labor Contractor's License (for additional informationon the .Farm Labor License, refer to Chapter 2). Since Oregon may be the only statethat requires a license, you may wish to contact the Forest Service or Bureau of Land

Management to obtain additional information on whether or not the individualsreceiving subcontractor payments are valid subcontractors.

If you determine that a reclassification issue exists, you will want to first determine if the taxpayer has an IRC section 530 safe haven. If the taxpayer does not have an IRC

section 530 safe haven, then you will need to consider whether or not the taxpayer isallowed the relief provisions of IRC section 3509.

If the taxpayer has not filed returns, you will need to give proper consideration to theuse of either Delinquent Return or Substitute for Return procedures which arediscussed below.

Delinquent or Substitute for Return: If the contractor has not filed employment tax

returns and you make the determination that a portion of the subcontractor paymentsare, in fact, employee wages, you will need to follow either the Delinquent orSubstitute for Return procedures.

When it has been determined that the contractors are required to file employment taxreturns but do not have an EIN, you will need to secure a EIN before you can closethe case. An EIN can be quickly obtained from the Service Center by using the

following procedure.

Securing an Employer"s Identification Number (EIN):

If the employer does not have an EIN, the examiner should assist in securing one. The

following procedure will allow the examiner to secure a number quickly:

1. Form SS-4 should be prepared for the employer.



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2. Call the Service Center servicing your District.

a. The Service Center will ask for information directly off the prepared FormSS-4.

b. In the upper-left corner of the completed Form SS-4, type the newly assignedEIN number and an ID number that will be given to you by the Service Center.

c. Mail the completed Form SS-4 to the Service Center servicing your districtwithin 5 days from the time the new EIN number has been

Cash Wages Deducted on the Return

Deductions for cash wages may be identified on the return as labor under cost of

goods sold, as contract labor, or commissions. If wage expense has been increased bycash wages paid, the issue will become apparent when you reconcile payroll.

Requesting employment tax return transcripts, prior to beginning the examination willhelp you determine if employment taxes are being filed and will show FICA wagesreported by the contractor.

Deductions for cash wages may be combined with other business expenses. It may notbe easy to identify whether or not the contractors are deducting wages paid in cash

since the contractors do not maintain adequate books and records. Therefore, if youdo not identify this issue during the pre-audit of the return, be sure to includequestions about cash payments in the initial interview. Ask the contractors if they ever

use cash to pay business expenses, find out what types of expenses are paid by cash,and ask the contractors if they pay employees in cash. This information will be useful

as the audit progresses.

Unsubstantiated Cash Expenses

The group has found that, within this industry, dealing in cash is common whileretaining receipts seems to be uncommon. Since it is very difficult to disallow allunsubstantiated expenses you need to determine if the contractor's testimony (from the

initial interview or later interviews) is corroborated by the documents you have beengiven. The contractor's receipts should support the contractor's need to deal in cash.For example, the contractors report that cash is needed by their foremen to purchase

gas and food for the employees when they are in remote forest areas. The receiptsshould be for gas and food that has been purchased outside of the contractor's home

town. The group found contractors giving the following explanations to substantiatethe use of cash:



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1. Checks Issued to the Foreman or to Cash

As previously mentioned, contractors may be deducting checks issued to theirforemen or to cash as other business expenses, (that is, auto expenses, etc.). Thecontractor's defense is that the reforestation industry is cash intensive. They report

that their foremen need cash to manage the workers while in remote forest areas.According to the contractors, the foremen are unable to cash personal checks andthey do not have credit cards to purchase food or gas or to pay lodging for the

workers. To determine if the contractor's testimony is consistent with the records,you will want to ask to see the employee reimbursement vouchers. The contractormust pay such benefits pursuant to an "accountable plan" as defined in the

regulations issued under IRC section 62(C); otherwise theadvances/reimbursements must be included on the employee's Form W-2. Notethat substantiation is required by IRC section 274(d).

If you suspect that the contractor is paying wages in cash, be sure to ask the

contractor for copies of his or her job bids. You will be able to use the job bids todevelop a percentage (wages as a percentage of gross income) to compare to thereturn. If the percentage of wages per the return is less than the amounts reported

on the job bids then the contractor most likely is paying wages in cash. You willalso want to request the payroll records and compare the hourly rate per thepayroll to the hourly rate per the job bids, looking for differences.

If the contractor does not provide adequate substantiation for either employeereimbursements or cash expenditures and if receipts do not agree with oral

testimony, the unsubstantiated expense may be disallowed under IRC section 162.However, if you have sufficient facts to indicate that wages were paid in cash, an

alternative position is to allow the payments as wage expense under IRC section162 and set up the related employment tax liabilities.

2. Payment of Expenses for Employees

Sometimes the contractors may be including items paid on behalf of theiremployees as ordinary and necessary business expenses. For example, the

contractor may be paying employees' apartment rent or buying their gas, clothing,or groceries. The contractor's defense is that he or she must provide for his or heremployees since the workers are nonresident aliens or that it is a requirement of .

their job.

These employer-provided items are "fringe benefits." A fringe benefit is anyproperty or service (or cash under certain circumstances) that an employeereceives from his or her employer in lieu of or in addition to regular taxable wages.

If a benefit is not specifically excluded from gross income by the Code (for



The regulations under section 62 of the Code provide that an arrangement will satisfy1

the business connection requirement if reimbursements or allowances are provided for expenses

that are deductible under sections 161 through 196 of the Code. In the reforestation industry,these expenses are deductible solely under section 162 of the Code.

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example, IRC sections 105, 106, 107, 117(d), 119, 120, 125, 127, 129, and 132),its value must be treated as compensation and reported as wages on the employee's

Form W-2.

Under IRC section 119, an employee may exclude from gross income the value of

any meals or lodging furnished in kind to the employee by or on behalf of theemployer for the convenience of the employer, provided that certain requirementsare met. Meals must be furnished on the business premises of the employer, and,

in the case of lodging, the employee must accept lodging on the business premisesof the employer as a condition of employment. IRC section 119 does not permitan employee to exclude from gross income cash the employer gives the employee

to purchase meals or lodging.

Amounts paid for an employee's meals, lodging, or gasoline may be excluded from

the employee's income to the extent the amounts are reimbursements or allowancesfor travel expenses incurred by the employee while "away from home" and are paid

under an accountable plan as described in the regulations under IRC section 62(c).In general, a reimbursement or other expense allowance arrangement is anaccountable plan if the requirements of business connection, timely substantiation,

and timely return of amounts in excess of expenses are satisfied.

In general, an arrangement that provides advances, allowance, or reimbursements

for business expenses paid or incurred by the employee in connection withperforming services as an employee of the employer and that are deductible underIRC section 162 will satisfy the business connection requirement . If amounts are1

provided for expenses that are not deductible under IRC section 162, the businessconnection requirement is not satisfied. For example, travel expenses are

deductible only if the employee is "away from home." Accordingly, it is importantto establish whether the employees are, in fact, away from home for tax purposes.Copies of the contract award letters will probably give you the job locations. Youshould be able to match the cash receipts by date and location to the contract

award letters.

If an arrangement is not an accountable plan, all amounts paid thereunder are

treated as paid under a nonaccountable plan, are required to be reported on theemployee's Form W-2, and are wages for purposes of withholding and payment of employment taxes.



Employer-provided clothing may be excluded from the employee's gross income asa working condition fringe benefit under IRC section 132(d) provided the clothing

is a special item required in the employee's work that does not replace items of ordinary clothing. Examples of such items include work shoes or special gloves,and a "uniform" that is required as a condition of employment and that is not

adaptable to general wear. An employer may provide a working condition fringebenefit in cash, provided that the employee verifies that the payment was actuallyused for the intended expense and any excess cash is returned to the employer.

Any of an employee's personal, living, or family expenses, such as travel that is notaway from home, that are paid for or provided in kind by the employer must be

included in the employee's income and reported on Form W-2. See IRC section262.

To determine whether a fringe benefit furnished to an employee is wages foremployment tax purposes, look at the definitions of wages and the exclusions

therefrom which are found in IRC section 3121(a) for FICA purposes, IRC section3306(b) for FUTA purposes, and IRC section 3401(a) for income tax withholding.

3. Payments to Nonresident Aliens

In general, if you pay wages to nonresident aliens, you must withhold income tax

(unless excepted by regulations) and Social Security taxes as you would for a U.S.citizen. The wages are subject to FICA and FUTA taxes. Nonresident aliens canbe exempted from "wages" under a U.S. treaty provision, if the alien is lawfully

admitted into the United States to do agricultural labor. Tree planters and treethinners are not considered to be agriculture workers and, therefore, are not

exempted from FICA or FUTA.

Contractors may report that they are paying the expenses of the nonresident aliensbrought to the United States to plant trees. Again these payments are considered

to be additional compensation to an already existing employee unless IRC section119 applies.

Employees temporarily admitted into the United States to do agricultural work areexempt from FICA and FUTA provided they are admitted to the United Statesunder the H-2 Visa program. Under the H-2 Visa program, the employer is

responsible to secure a visa, provide transportation for the workers both to andfrom Mexico, as well as house the nonresident aliens while they are working in the

United States. Immigration (INS) should be contacted to determine if, to whom,and how many H-2 Visas have been given out in your State.